The first step in determining the price you can afford to pay for a home is to get a clear picture of your current financial situation.
Be aware of your monthly payments on any loans or credit cards, and of your total gross (before taxes) monthly household income.
Lending institutions follow two simple affordability rules to determine how much you can pay.
The first affordability rule is that your monthly housing costs shouldn’t be more than 32 per cent of your gross household monthly income.
In this case, housing costs are considered to include monthly mortgage payments, property taxes and heating expenses — known as P.I.T.H. for short.
For a condominium, P.I.T.H. also includes half of the monthly condominium fees.
Lenders add up these housing costs to determine what percentage they are of your gross monthly income.
This figure is known as your gross debt service (GDS) ratio. Remember, it must be 32 per cent or less of your gross household monthly income.
The second affordability rule is that your entire monthly debt load shouldn’t be more than 40 per cent of your gross monthly income. This includes housing costs and other debts, such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your gross household monthly income. This figure is your Total Debt Service (TDS) ratio.
This will tell you what your maximum monthly payments should be. But the home price you can afford depends on several other factors, too.
Specifically, these are the amount of your down payment and the current interest rate.
For most people, the hardest part of buying a home — especially your first one — is saving a down payment.
Many people will not have 20 per cent of the purchase price to put down. With mortgage loan insurance, though, you can purchase a home with less.
Mortgage loan insurance protects the lender. By law, most Canadian lending institutions require it.
The way it works is if the borrower defaults on the mortgage (fails to pay), the lender is paid back by the insurer. The cost for this type of insurance can be paid in a single lump sum, or it can be added to your mortgage and included in your payments.
Most mortgage loan insurance products require homebuyers to provide the down payment from their own resources, such as savings and RRSPs. Gift down payments from immediate relatives are also acceptable.
For down payments of less than 10 per cent, CMHC enables lenders to offer homebuyers the flexibility to use additional sources of down payment, such as borrowed funds or lender incentives.
Once you’ve made the necessary calculations, rounded up a down payment and feel you are ready to obtain a mortgage, it’s a good idea to get pre-approval.
This means that a lender will look at your finances to establish the amount of mortgage you can afford. At that time, the lender will give you a written confirmation or certificate quoting a fixed interest rate, good for a specific period of time.
Having a pre-approved mortgage amount makes the search for your new home much easier and less time-consuming, because you have a price in mind.
Some of the things you will need to have with you the first time you meet with a lender are:
Your personal information, including picture identification;
Details about your job, including confirmation of salary in the form of a letter from your employer;
Your sources of income;
Information and details about bank accounts, loans and debts;
Proof of financial assets;
Source and amount of down payment and deposit;
Proof of source of funds for closing costs (these are usually between 1.5 per cent and four per cent of the purchase price) .
Your calculations may show that you will have trouble meeting the monthly debt payment on the home you want, and that you will likely have trouble getting approved for a mortgage.
Here are some things you can do:
Pay off some loans first;
Save for a larger down payment;
Revise your target house price;
Meet with a credit counsellor who can help you minimize your debts;
Buy your home through a rent-to-own program provided by the builder, a non-profit sponsor or a government sponsor.
Your credit rating
Before approving you for a mortgage, lenders will want to see how well you have paid your debts and bills in the past.
To do this, they get a copy of your credit report. This provides them with information on your financial past and use of credit.
Before your lender sees your credit history, get a copy for yourself to make sure the information is accurate. Contact one of the two main credit-reporting agencies, Equifax Canada Inc. or TransUnion of Canada, to get your credit report. (There may be a fee for this.)
If you have no credit history, it is important to build one. One way is to apply for a standard credit card, make small purchases and pay for them as soon as the bill comes in.
If you have bad credit, lenders might not want to give you a mortgage until you can re-establish a good credit history by making debt payments regularly and on time.
Most unfavourable credit information, including bankruptcy, is dropped from your credit file after seven years. If you have bad credit, you may want to consider credit counselling.
Despite a poor credit history, you might still be able to get a mortgage loan if you have a family member willing to be a guarantor or co-signer on the loan.
This person must meet the lender’s borrowing criteria, including good credit history, and is legally obligated to make the mortgage payments if you do not.